garrison file

1. Copyright © 2006, The McGraw-Hill Companies, Inc.
McGraw-Hill/Irwin
11th Edition
Chapter 3

2. Copyright © 2006, The McGraw-Hill Companies, Inc.
McGraw-Hill/Irwin
Chapter Three
Systems Design:
Job-Order Costing

3. Copyright © 2006, The McGraw-Hill Companies, Inc.
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Types of Product Costing Systems
Process
Costing
Job-order
Costing
❖ A company produces many units of a single
product.
❖ One unit of product is indistinguishable from
other units of product.
❖ The identical nature of each unit of product enables
assigning the same average cost per unit.

4. Copyright © 2006, The McGraw-Hill Companies, Inc.
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Types of Product Costing Systems
Process
Costing
Job-order
Costing
❖ A company produces many units of a single
product.
❖ One unit of product is indistinguishable from
other units of product.
❖ The identical nature of each unit of product enables
assigning the same average cost per unit.
Example companies:
1. Weyerhaeuser (paper manufacturing)
2. Reynolds Aluminum (refining aluminum ingots)
3. Coca-Cola (mixing and bottling beverages)

5. Copyright © 2006, The McGraw-Hill Companies, Inc.
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Types of Product Costing Systems
Process
Costing
Job-order
Costing
❖ Many different products are produced each period.
❖ Products are manufactured to order.
❖ The unique nature of each order requires tracing or
allocating costs to each job, and maintaining cost
records for each job.

6. Copyright © 2006, The McGraw-Hill Companies, Inc.
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Types of Product Costing Systems
Process
Costing
Job-order
Costing
❖ Many different products are produced each period.
❖ Products are manufactured to order.
❖ The unique nature of each order requires tracing or
allocating costs to each job, and maintaining cost
records for each job.
Example companies:
1. Boeing (aircraft manufacturing)
2. Bechtel International (large scale construction)
3. Walt Disney Studios (movie production)

7. Copyright © 2006, The McGraw-Hill Companies, Inc.
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Comparing Process and Job-Order Costing
Job-Order Process
Number of jobs worked Many Single Product
Cost accumulated by
Individual
Job Department
Average cost computed by Job Department

8. Copyright © 2006, The McGraw-Hill Companies, Inc.
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Quick Check ✓
Which of the following companies would
be likely to use job-order costing rather
than process costing?
a. Scott Paper Company for Kleenex.
b. Architects.
c. Heinz for ketchup.
d. Caterer for a wedding reception.
e. Builder of commercial fishing vessels.

9. Copyright © 2006, The McGraw-Hill Companies, Inc.
McGraw-Hill/Irwin
Quick Check ✓
Which of the following companies would
be likely to use job-order costing rather
than process costing?
a. Scott Paper Company for Kleenex.
b. Architects.
c. Heinz for ketchup.
d. Caterer for a wedding reception.
e. Builder of commercial fishing vessels.

10. Copyright © 2006, The McGraw-Hill Companies, Inc.
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Manufacturing
Overhead
Job No. 1
Job No. 2
Job No. 3
Charge
direct
material and
direct labor
costs to
each job as
work is
performed.
Direct Manufacturing Costs
Direct Materials
Direct Labor

11. Copyright © 2006, The McGraw-Hill Companies, Inc.
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Manufacturing
Overhead,
including
indirect
materials and
indirect labor,
are allocated to
jobs rather than
directly traced
to each job.
Direct Manufacturing Costs
Direct Materials
Direct Labor
Job No. 1
Job No. 2
Job No. 3
Manufacturing
Overhead

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PearCo Job Cost Sheet
Job Number A - 143 Date Initiated 3-4-05
Date Completed
Department B3 Units Completed
Item Wooden cargo crate
Direct Materials Direct Labor Manufacturing Overhead
Req. No. Amount Ticket Hours Amount Hours Rate Amount
Cost Summary Units Shipped
Direct Materials Date Number Balance
Direct Labor
Manufacturing Overhead
Total Cost
Unit Product Cost
Job-Order Cost Accounting

13. Copyright © 2006, The McGraw-Hill Companies, Inc.
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Materials Requisition Form
Will E. Delite

14. Copyright © 2006, The McGraw-Hill Companies, Inc.
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Job-Order Cost Accounting

15. Copyright © 2006, The McGraw-Hill Companies, Inc.
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Employee Time Ticket

16. Copyright © 2006, The McGraw-Hill Companies, Inc.
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Job-Order Cost Accounting

17. Copyright © 2006, The McGraw-Hill Companies, Inc.
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Why Use an Allocation Base?
Manufacturing overhead is applied to jobs that
are in process. An allocation base, such as
direct labor hours, direct labor dollars, or
machine hours, is used to assign
manufacturing overhead to individual jobs.
We use an allocation base because:
1. It is impossible or difficult to trace overhead costs to particular jobs.
2. Manufacturing overhead consists of many different items ranging
from the grease used in machines to production manager’s salary.
3. Many types of manufacturing overhead costs are fixed even though
output fluctuates during the period.

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The predetermined overhead rate (POHR)
used to apply overhead to jobs is
determined before the period begins.
Manufacturing Overhead Application
Estimated total manufacturing
overhead cost for the coming period
Estimated total units in the
allocation base for the coming period
POHR =
Ideally, the allocation base
is a cost driver that causes
overhead.

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Using a predetermined rate makes it
possible to estimate total job costs sooner.
Actual overhead for the period is not
known until the end of the period.
The Need for a POHR
$

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Actual amount of the allocation
based upon the actual level of
activity.
Based on estimates, and
determined before the
period begins.
Application of Manufacturing Overhead
Overhead applied = POHR × Actual activity

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For each direct labor hour worked on a
particular job, $4.00 of factory overhead
will be applied to that job.
Overhead Application Rate
POHR = $4.00 per DLH
$640,000
160,000 direct labor hours (DLH)
POHR =
Estimated total manufacturing
overhead cost for the coming period
Estimated total units in the
allocation base for the coming period
POHR =

22. Copyright © 2006, The McGraw-Hill Companies, Inc.
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Job-Order Cost Accounting

23. Copyright © 2006, The McGraw-Hill Companies, Inc.
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Job-Order Cost Accounting

24. Copyright © 2006, The McGraw-Hill Companies, Inc.
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Interpreting the Average Unit Cost
The average unit cost should not be interpreted
as the costs that would actually be incurred if an
additional unit were produced.
Fixed overhead would not change if another unit
were produced, so the incremental cost of
another unit may be somewhat less than $118.

25. Copyright © 2006, The McGraw-Hill Companies, Inc.
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Quick Check ✓
Job WR53 at NW Fab, Inc. required $200 of
direct materials and 10 direct labor hours at
$15 per hour. Estimated total overhead for
the year was $760,000 and estimated direct
labor hours were 20,000. What would be
recorded as the cost of job WR53?
a. $200.
b. $350.
c. $380.
d. $730.

26. Copyright © 2006, The McGraw-Hill Companies, Inc.
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Quick Check ✓
Job WR53 at NW Fab, Inc. required $200 of
direct materials and 10 direct labor hours at
$15 per hour. Estimated total overhead for
the year was $760,000 and estimated direct
labor hours were 20,000. What would be
recorded as the cost of job WR53?
a. $200.
b. $350.
c. $380.
d. $730.
Pred. ovhd. rate $760,000/20,000hours $38
Direct materials $200
Direct labor $15 x 10 hours $150
Manufacturing overhead $38 x 10 hours $380
Total cost $730

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Let’s summarize
the document flow
in a job-order
costing system.
Job-Order Costing
Document Flow Summary

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Job-Order Costing
Document Flow Summary
A sales order is the
basis of issuing a
production order.
A production
order initiates
work on a job.

29. Copyright © 2006, The McGraw-Hill Companies, Inc.
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Job-Order Costing
Document Flow Summary
Job Cost
Sheets
Materials
Requisition
Manufacturing
Overhead
Account
Direct
materials
Indirect
materials
Materials used
may be either
direct or
indirect.

30. Copyright © 2006, The McGraw-Hill Companies, Inc.
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Job-Order Costing
Document Flow Summary
Job Cost
Sheets
Employee Time
Ticket
Manufacturing
Overhead
Account
An employee’s
time may be either
direct or indirect.
Direct
Labor
Indirect
Labor

31. Copyright © 2006, The McGraw-Hill Companies, Inc.
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Job-Order Costing
Document Flow Summary
Manufacturing
Overhead
Account
Other
Actual OH
Charges
Job Cost
Sheets
Applied
Overhead
Materials
Requisition
Employee
Time Ticket
Indirect
Material
Indirect
Labor

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Job-Order System Cost Flows
Let’s examine the
cost flows in a
job-order costing
system.

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Raw Materials
⚫Material
Purchases
Mfg. Overhead
Work in Process
(Job Cost Sheet)
Actual Applied
⚫Direct
Materials ⚫Direct
Materials
⚫Indirect
Materials
⚫Indirect
Materials
Job-Order System Cost Flows

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Cost Flows – Material Purchases
Raw material purchases are recorded in an
inventory account.

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Cost Flows – Material Usage
Direct materials issued to a job increase Work in
Process and decrease Raw Materials. Indirect
materials used are charged to Manufacturing
Overhead and also decrease Raw Materials.

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Mfg. Overhead
Salaries and
Wages Payable
Work in Process
(Job Cost Sheet)
⚫Direct
Materials
⚫Direct
Labor
⚫Direct
Labor
⚫Indirect
Materials
Actual Applied
⚫Indirect
Labor
⚫Indirect
Labor
Job-Order System Cost Flows

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Cost Flows – Labor
The cost of direct labor incurred increases Work in
Process and the cost of indirect labor increases
Manufacturing Overhead.

38. Copyright © 2006, The McGraw-Hill Companies, Inc.
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Mfg. Overhead
Salaries and
Wages Payable
Work in Process
(Job Cost Sheet)
⚫Direct
Materials
⚫Direct
Labor
⚫Direct
Labor
⚫Indirect
Materials
Actual Applied
⚫Indirect
Labor
⚫Indirect
Labor
Job-Order System Cost Flows
⚫Other
Overhead

39. Copyright © 2006, The McGraw-Hill Companies, Inc.
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Cost Flows – Actual Overhead
In addition to indirect materials and indirect labor,
other manufacturing overhead costs are charged to
the Manufacturing Overhead account as they are
incurred.

40. Copyright © 2006, The McGraw-Hill Companies, Inc.
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Mfg. Overhead
Salaries and
Wages Payable
Work in Process
(Job Cost Sheet)
⚫Direct
Materials
⚫Direct
Labor
⚫Direct
Labor
⚫Indirect
Materials
Actual Applied
⚫Indirect
Labor
⚫Indirect
Labor
Job-Order System Cost Flows
⚫Other
Overhead
⚫Overhead
Applied
⚫Overhead
Applied to
Work in
Process
If actual and applied
manufacturing overhead
are not equal, a year-end
adjustment is required.

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Cost Flows – Overhead Applied
Work in Process is increased when
Manufacturing Overhead is applied to jobs.

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Nonmanufacturing Cost Flows
Nonmanufacturing costs are not assigned to
individual jobs, rather they are expensed in the
period incurred.
Examples:
1. Salary expense of employees
that work in a marketing, selling,
or administrative capacity.
2. Advertising expenses are expensed
in the period incurred.

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Nonmanufacturing Cost Flows
Nonmanufacturing costs (period expenses) are
charged to expense as they are incurred.

44. Copyright © 2006, The McGraw-Hill Companies, Inc.
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Finished Goods
Work in Process
(Job Cost Sheet)
⚫Direct
Materials
⚫Direct
Labor
⚫Overhead
Applied
⚫Cost of
Goods
Mfd.
⚫Cost of
Goods
Mfd.
Job-Order System Cost Flows

45. Copyright © 2006, The McGraw-Hill Companies, Inc.
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Cost Flows – Cost of Goods Manufactured
As jobs are completed, the Cost of Goods
Manufactured is transferred to Finished Goods
from Work in Process.

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Finished Goods
Cost of Goods Sold
Work in Process
(Job Cost Sheet)
⚫Direct
Materials
⚫Direct
Labor
⚫Overhead
Applied
⚫Cost of
Goods
Mfd.
⚫Cost of
Goods
Mfd.
⚫Cost of
Goods
Sold
⚫Cost of
Goods
Sold
Job-Order System Cost Flows

47. Copyright © 2006, The McGraw-Hill Companies, Inc.
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Cost Flows – Sales
When finished goods are sold, two entries are
required: (1) to record the sale, and (2) to
record COGS and reduce Finished Goods.

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Defining Under- and Overapplied Overhead
The difference between the overhead cost applied to
Work in Process and the actual overhead costs of a
period is termed either underapplied or overapplied
overhead.
Underapplied overhead
exists when the amount of
overhead applied to jobs
during the period using the
predetermined overhead
rate is less than the total
amount of overhead actually
incurred during the period.
Overapplied overhead
exists when the amount of
overhead applied to jobs
during the period using the
predetermined overhead
rate is greater than the total
amount of overhead actually
incurred during the period.

49. Copyright © 2006, The McGraw-Hill Companies, Inc.
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PearCo’s actual overhead for the year was
$650,000 with a total of 170,000 direct labor
hours worked on jobs.
How much total overhead was applied to
PearCo’s jobs during the year? Use
PearCo’s predetermined overhead rate of
$4.00 per direct labor hour.
Overhead Application Example
Overhead Applied During the Period
Applied Overhead = POHR × Actual Direct Labor Hours
Applied Overhead = $4.00 per DLH × 170,000 DLH = $680,000

50. Copyright © 2006, The McGraw-Hill Companies, Inc.
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PearCo’s actual overhead for the year was
$650,000 with a total of 170,000 direct labor
hours worked on jobs.
How much total overhead was applied to
PearCo’s jobs during the year? Use
PearCo’s predetermined overhead rate of
$4.00 per direct labor hour.
Overhead Application Example
Overhead Applied During the Period
Applied Overhead = POHR × Actual Direct Labor Hours
Applied Overhead = $4.00 per DLH × 170,000 DLH = $680,000
PearCo has overapplied
overhead for the year
by $30,000. What will
PearCo do?

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Tiger, Inc. had actual manufacturing overhead
costs of $1,210,000 and a predetermined
overhead rate of $4.00 per machine hour. Tiger,
Inc. worked 290,000 machine hours during the
period. Tiger’s manufacturing overhead is
a. $50,000 overapplied.
b. $50,000 underapplied.
c. $60,000 overapplied.
d. $60,000 underapplied.
Quick Check ✓

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Tiger, Inc. had actual manufacturing overhead
costs of $1,210,000 and a predetermined
overhead rate of $4.00 per machine hour. Tiger,
Inc. worked 290,000 machine hours during the
period. Tiger’s manufacturing overhead is
a. $50,000 overapplied.
b. $50,000 underapplied.
c. $60,000 overapplied.
d. $60,000 underapplied.
Quick Check ✓
Overhead Applied
$4.00 per hour × 290,000 hours
= $1,160,000
Underapplied Overhead
$1,210,000 - $1,160,000
= $50,000

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Disposition of Under- or Overapplied Overhead
$30,000 may be
closed directly to
cost of goods sold.
Cost of
Goods Sold
PearCo’s Method
Work in
Process
Finished
Goods
Cost of
Goods Sold
$30,000
may be allocated
to these accounts.
OR

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Disposition of Under- or Overapplied Overhead
PearCo’s
Mfg. Overhead
Actual
overhead
costs
$650,000
$30,000
overapplied
PearCo’s Cost
of Goods Sold
Unadjusted
Balance
Adjusted
Balance
$30,000
$30,000
Overhead
applied
to jobs
$680,000

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Allocating Under- or Overapplied
Overhead Between Accounts
Amount
Percent of
Total
Allocation of
$30,000
Work in process 68,000
$ 10% 3,000
$
Finished Goods 204,000 30% 9,000
Cost of Goods Sold 408,000 60% 18,000
Total 680,000
$ 100% 30,000
$
Assume the overhead applied in ending Work in
Process Inventory, ending Finished Goods
Inventory, and Cost of Goods Sold is shown below:

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Allocating Under- or Overapplied
Overhead Between Accounts
Amount
Percent of
Total
Allocation of
$30,000
Work in process 68,000
$ 10% 3,000
$
Finished Goods 204,000 30% 9,000
Cost of Goods Sold 408,000 60% 18,000
Total 680,000
$ 100% 30,000
$
We would complete the following allocation of
$30,000 overapplied overhead:

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Allocating Under- or Overapplied
Overhead Between Accounts
Amount
Percent of
Total
Allocation of
$30,000
Work in process 68,000
$ 10% 3,000
$
Finished Goods 204,000 30% 9,000
Cost of Goods Sold 408,000 60% 18,000
Total 680,000
$ 100% 30,000
$

58. Copyright © 2006, The McGraw-Hill Companies, Inc.
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Overapplied and Underapplied Manufacturing
Overhead - Summary
Alternative 1 Alternative 2
If Manufacturing Close to Cost
Overhead is . . . of Goods Sold Allocation
UNDERAPPLIED INCREASE INCREASE
Cost of Goods Sold Work in Process
(Applied OH is less Finished Goods
than actual OH) Cost of Goods Sold
OVERAPPLIED DECREASE DECREASE
Cost of Goods Sold Work in Process
(Applied OH is greater Finished Goods
than actual OH) Cost of Goods Sold
PearCo’s
Method

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Quick Check ✓
What effect will the overapplied overhead
have on PearCo’s net operating income?
a. Net operating income will increase.
b. Net operating income will be unaffected.
c. Net operating income will decrease.

60. Copyright © 2006, The McGraw-Hill Companies, Inc.
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Quick Check ✓
What effect will the overapplied overhead
have on PearCo’s net operating income?
a. Net operating income will increase.
b. Net operating income will be unaffected.
c. Net operating income will decrease.

61. Copyright © 2006, The McGraw-Hill Companies, Inc.
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Multiple Predetermined Overhead Rates
To this point we have assumed that there is a
single predetermined overhead rate called a
plantwide overhead rate.
Large companies
often use multiple
predetermined
overhead rates.
May be more
complex but . . .
May be more
accurate because it
reflects differences
across departments.

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Job-Order Costing in Service Companies
Job-order costing is used in many
difference types of service companies.

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The Use of Information Technology
Technology plays an important part in many
job-order cost systems. When combined with
Electronic Data Interchange (EDI) or a web-
based programming language called
Extensible Markup Language (XML), bar
coding eliminates the inefficiencies and
inaccuracies associated with manual clerical
processes.

64. Copyright © 2006, The McGraw-Hill Companies, Inc.
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Appendix 3a
The Predetermined Overhead
Rate & Capacity

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Predetermined Overhead Rate and Capacity
Calculating predetermined overhead rates using
an estimated, or budgeted amount of the
allocation base has been criticized because:
1. Basing the predetermined overhead rate upon
budgeted activity results in product costs that
fluctuate depending upon the activity level.
2. Calculating predetermined rates based upon
budgeted activity charges products for costs that
they do not use.

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Capacity-Based Overhead Rates
Criticisms can be overcome by using
estimated total units in the allocation base at
capacity in the denominator of the
predetermined overhead rate calculation.
Let’s look at the difference!

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An Example
Equipment is leased for $100,000 per year.
Running at full capacity, 50,000 units may be
produced. The company estimates that 40,000 units
will be produced and sold next year. What is the
predetermined overhead rate?

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An Example
Equipment is leased for $100,000 per year.
Running at full capacity, 50,000 units may be
produced. The company estimates that 40,000 units
will be produced and sold next year. What is the
predetermined overhead rate?
Traditional
Method
= $2.50 per unit
$100,000
40,000
=
Capacity
Method
= $2.00 per unit
$100,000
50,000
=

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Quick Check ✓
Crest Winery in Woodinville leases an automatic
corking machine for $100,000 per year. If run at
full capacity, it can cork 50,000 cases of wine
per year. The company estimates 40,000 cases
of wine will be produced and sold next year.
What is the predetermined overhead rate based
on the estimated number of cases of wine?
a. $2.00 per case.
b. $2.50 per case.
c. $4.00 per case.

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Quick Check ✓
Crest Winery in Woodinville leases an automatic
corking machine for $100,000 per year. If run at
full capacity, it can cork 50,000 cases of wine
per year. The company estimates 40,000 cases
of wine will be produced and sold next year.
What is the predetermined overhead rate based
on the estimated number of cases of wine?
a. $2.00 per case.
b. $2.50 per case.
c. $4.00 per case.

71. Copyright © 2006, The McGraw-Hill Companies, Inc.
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Quick Check ✓
Crest Winery in Woodinville leases an automatic
corking machine for $100,000 per year. If run at
full capacity, it can cork 50,000 cases of wine
per year. The company estimates 40,000 cases
of wine will be produced and sold next year.
What is the predetermined overhead rate based
on the number of cases of wine at capacity?
a. $2.00 per case.
b. $2.50 per case.
c. $4.00 per case.

72. Copyright © 2006, The McGraw-Hill Companies, Inc.
McGraw-Hill/Irwin
Quick Check ✓
Crest Winery in Woodinville leases an automatic
corking machine for $100,000 per year. If run at
full capacity, it can cork 50,000 cases of wine
per year. The company estimates 40,000 cases
of wine will be produced and sold next year.
What is the predetermined overhead rate based
on the number of cases of wine at capacity?
a. $2.00 per case.
b. $2.50 per case.
c. $4.00 per case.

73. Copyright © 2006, The McGraw-Hill Companies, Inc.
McGraw-Hill/Irwin
Quick Check ✓
When capacity is used in the denominator in the
predetermined rate, what happens to the
predetermined overhead rate as estimated
activity decreases?
a. The predetermined overhead rate goes up when
activity goes down.
b. The predetermined overhead rate stays the
same; it is not affected by changes in activity.
c. The predetermined overhead rate goes down
when activity goes down.

74. Copyright © 2006, The McGraw-Hill Companies, Inc.
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Quick Check ✓
When capacity is used in the denominator in the
predetermined rate, what happens to the
predetermined overhead rate as estimated
activity decreases?
a. The predetermined overhead rate goes up when
activity goes down.
b. The predetermined overhead rate stays the
same; it is not affected by changes in activity.
c. The predetermined overhead rate goes down
when activity goes down.

75. Copyright © 2006, The McGraw-Hill Companies, Inc.
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Quick Check ✓
When estimated activity is used in the
denominator in the predetermined rate, what
happens to the predetermined overhead rate as
estimated activity decreases?
a.The predetermined overhead rate goes up when
activity goes down.
b.The predetermined overhead rate stays the
same; it is not affected by changes in activity.
c.The predetermined overhead rate goes down
when activity goes down.

76. Copyright © 2006, The McGraw-Hill Companies, Inc.
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Quick Check ✓
When estimated activity is used in the
denominator in the predetermined rate, what
happens to the predetermined overhead rate as
estimated activity decreases?
a.The predetermined overhead rate goes up when
activity goes down.
b.The predetermined overhead rate stays the
same; it is not affected by changes in activity.
c.The predetermined overhead rate goes down
when activity goes down.

77. Copyright © 2006, The McGraw-Hill Companies, Inc.
McGraw-Hill/Irwin
Basing the rate on capacity
Actual volume 40,000 cases
Selling price $40.00 per case
Variable production cost $24.00 per case
Fixed manufacturing overhead $100,000 per year
Capacity 50,000 cases
Predetermined overhead rate $2.00 per case
Fixed selling and admin. expense $500,000 per year
Revenue 1,600,000
$
Cost of goods sold 1,040,000
Gross margin 560,000
Cost of idle capacity 20,000
Selling and admin. expense 500,000
Net operating income 40,000
$

78. Copyright © 2006, The McGraw-Hill Companies, Inc.
McGraw-Hill/Irwin
Actual volume 40,000 cases
Selling price $40.00 per case
Variable production cost $24.00 per case
Fixed manufacturing overhead $100,000 per year
Expected volume 40,000 cases
Predetermined overhead rate $2.50 per case
Fixed selling and admin. expense $500,000 per year
Revenue 1,600,000
$
Cost of goods sold 1,060,000
Gross margin 540,000
Cost of idle capacity -
Selling and admin. expense 500,000
Net operating income 40,000
$
Basing the rate on expected volume

79. Copyright © 2006, The McGraw-Hill Companies, Inc.
McGraw-Hill/Irwin
End of Chapter 3